COST SEGREGATION &
PROPERTY TAX SERVICES
April 21, 2002
Written by Cal Fugitt
For many years and in all industries, taxpayers
have utilized cost segregation and purchase price allocation techniques
to maximize depreciation benefits. The tax codes Modified
Accelerated Cost Recovery System (MACRS) or previously (ACRS)
has been modified over the years but is still essentially a method
to accelerate depreciation. Currently under MACRS residential real
property is depreciated on a straight-line basis over 27.5 years
and commercial/industrial property over 39 years. Some specialized
industries have specified lives such as oil & gas, utilities,
Under current tax law, when an income taxpayer
acquires or constructs a new facility, opportunities may exist to
more accurately classify and thus maximize federal and state tax
depreciation. This is done by identifying 5, 7, and 15-year property
typically included in allocated building or land values for acquired
real estate or in construction trade accounts for newly constructed
facilities. The shorter life and accelerated declining balance depreciation
methods (150% and 200%) available under MACRS can generate major
cash flow benefits in both current and future years for federal
and for most state income tax reporting purposes. Additionally,
at the time of acquisition or construction, remodeling or renovation
it is often a great time to position and review ones property
Identification and quantification of these personal
property and land improvement support costs may also be eligible
for investment credit or other tax exemptions. At the local and
some state levels, job creation investment credits, abatements and
exemptions can further enhance state or local tax benefits.
Previous acquisitions and construction projects,
which may have been overlooked, may now be worth a thorough review
due to recently issued IRS Revenue Proclamation Rulings (currently
Rev.Proc.2002-09) that allows retrospective identification and correction
of MACRS lives.
The 2002 Federal Tax Bill recently passed allow
additional depreciation (up to 30%) for qualified property acquired
after September 10, 2001. This allowance increases the valid reclassification
process even more. Its a fairly simple application but significant.
Individual States will differ on how this change will apply.
For property tax cost segregation purposes, tremendous
benefit can be realized by identifying non-assessable categories
in new construction. Items such as overtime premiums, fast track
construction elements, re-work, demolition or excess tie-in costs,
etc. which are included in the book and income tax basis of these
projects would be an indicator of lower beginning or base year value
for property tax purposes. It is important to keep in mind is that
cost does not always equal value. Optimistic deal economics may
not be realized initially and may warrant negotiation or appeal
proceedings with local property tax authorities.
Consulting on newly acquired or constructed real
property using a combined cost segregation and property tax perspective
can be very advantageous. The cost segregation services for every
dollar reclassified from 27.5 and 39 year into these shorter lived
categories can give back 10 cents to 22 cents or more on the dollar.
The positive impact on investor yields can amount to a percentage
point or more. There can also be positive impact on the value of
a property from increased cash flow, earnings per share (EPS), return
on assets (ROA), shareholder and partnership value, etc. all from
a more aggressive allowable and supportable review of these issues.
Property tax benefits vary by state and even by local statute and
practice. It is not unusual to find a 5% reduction of cost in a
$20 Million construction project. In a 1.1% taxing district, annual
saving would be approximately $11,000. These are generally benefits
that taxpayers will not realize without help. Fee to measurable
benefit payback can be more than ten to one for the cost segregation
work and property tax work is usually only executed if savings are
assured in advance with a preliminary review.
Bear in mind that these are studies that go beyond
a review of the invoices or line items on a contractors cost breakdown.
They may involve intensive engineering and application of knowledgeable
capital cost recovery expertise. Important to note is the requirement
for supportability in case of audit. The techniques mentioned above
are not new but are often overlooked or performed post transaction.
We believe management should be thinking about these issues while
youre lining up the architect and contractor for a new project
or in the due-diligence phase of an acquisition. It can enhance
the benefit and support the positions taken by involving everyone
in the process. It may also save money long term by organizing and
reporting costs in a format that can be readily incorporated into
a cost segregation report and eventually into your organizations
fixed assets record. Property tax work can be highly specialized
also. Many of the contingency fee providers dont
gain the perspective or double up the fee to provide their property
tax service that can be done with greater efficiency along with
the cost segregation work. Please call Cal Fugitt directly to find
out how these techniques can help your client.
Cal Fugitt is an accredited senior
member of the American Society of Appraisers (ASA) located in Sonoma,
California. He served as president of the Bay Area Chapter of the
ASA in 1987. Cal is a former Director with PricewaterhouseCoopers
LLP, San Francisco and has practiced appraisal & valuation,
construction consulting and property taxes since the early 1970s.
Cal is currently a principal in Cost Tech Consulting, a firm specializing
in providing cost segregation, property records review and purchase
price allocation services.